Stocks are in a ‘rational bubble’ as long as investors remain confident in continued Fed support, economist Mohamed El-Erian says

• Mohamed El-Erian told CNBC stocks are in a “rational bubble” and asset prices will continue to rise as long as the Federal Reserve signals to investors that it will continue to support the markets. 
• “It’s rational because the Fed and the ECB keep on signaling that they will continue to inject massive liquidity, and as long as the market is confident that that’s the case, it will drive prices higher,” the Allianz chief economic adviser said. 
• El-Erian said that the US will continue to see a contrast between what the market is doing and what the broader economy is indicating because of the liquidity in the market.
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Mohamed El-Erian told CNBC on Wednesday stocks are in a “rational bubble” at the moment and asset prices will continue to rise as long as the Federal Reserve signals to investors that it will continue to provide support for the markets.

“This is not an irrational bubble. This is a rational bubble,” the Allianz chief economic adviser said. “It’s rational because the Fed and the ECB keep on signaling that they will continue to inject massive liquidity, and as long as the market is confident that that’s the case, it will drive prices higher.”

Typically, a stock market bubble is created when asset prices surge to levels that greatly exceed the their intrinsic value. Legendary investor Jeremy Grantham said on Tuesday that the stock market is in a  “fully-fledged epic bubble,” driven by extreme overvaluations, explosive price increases, frenzied issuance, and “hysterically speculative investor behavior.” 

For El-Erian, there is a rational reason why stock prices keep going up, and it’s investor confidence in support from the Federal Reserve.

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Stock prices ballooned in 2020: the S&P 500 gaining 16%, while the tech-heavy Nasdaq soared 43%. El-Erian said there’s so much liquidity “sloshing around the system,” that stock prices will continue to move higher this year.

The result is that stock prices continue to rise despite political and economic turmoil outside of Wall Street.  On Wednesday as protesters stormed the US Capitol building, the stock market remained unbothered. The Dow Jones closed at a record high, while the S&P 500 closed up 0.5%. 

El-Erian said that the US will continue to see a contrast between what the market is doing and what “conditions on the ground” are saying because of the liquidity in the market.

Also on Wednesday, the ADP monthly employment report revealed that the US lost 123,000 private payrolls in December. The reading marks the first contraction in nationwide hiring since April. El-Erian said that the report was a “big miss” and demonstrates the “power of liquidity.”